– William Gibson, circa 1993 in an interview (original version of the quote)

The
political speech-fests are finally over. Republicans and Democrats conducted
largely violence-free quadrennial conventions – but not because everyone loves
each other. The disdain was palpable, both within and between the two parties.

On one
topic, however, both campaigns agree: global free trade has jumped the shark.
We haven’t seen this kind of protectionist rhetoric in a long time, at least
from major party candidates. Globalization is taking the blame for a wide
variety of ills. The trouble with all this dissing of globalization and free
trade is that, like some generals, both major political parties are fighting
the last war, not the ones we face today and tomorrow. And the Libertarian
Party seems to think that the correct philosophy by itself will cure the
problems, which it may do in the long run; but philosophy doesn’t pay the bills
or create jobs in the short run.

However,
we should recognize that aimless, disorganized criticism isn’t necessarily
wrong. Real economic problems led to Donald’s Trump’s GOP nomination. Ditto for
the strong Bernie Sanders run against Hillary Clinton. People aren’t just
imagining their pain.

I have
used the quote from William Gibson several times this year at the opening of
the letter: “The future is already here. It’s just not evenly distributed yet.”
I decided to do a little research on the quote and found that the popular
version actually comes from an interview in the documentary Cyberpunk. The quote evolved
over the next few years to today’s form. Most versions that you read, including
the one I’d been using, did not have the final word yet at the end of the sentence. And yet (he
wrote with a smile), for the purposes of today’s letter, that is the key word.
We are going to talk about the negative public sentiment that is surfacing in
the developed world and why the benefits of globalization are unevenly
distributed.

I
should note that I’m going to flesh out this whole concept in several chapters
of the book I’m writing about the changes coming in the next 20 years. We are
actually going to see large changes in the nature of globalization, and they
are going to have a profound impact on the future of work.

Here I
have to offer a mea culpa. I have used the line “I don’t know where the jobs
will come from in the future, but they will” numerous times over the last 10
years. That assertion is not just a glib statement; it actually reflects our
historical experience. It is part of the whole “creative destruction” concept –
that old industries and noncompetitive enterprises give way to innovative new
industries and more competitive enterprises that ultimately create more jobs.
Farm jobs went away, but jobs in factories and in the services sector were
created through the process of industrialization. Manufacturing became more
efficient in the ’60s, ’70s, and ’80s; and then the advent of the personal
computer, the Internet, and other “high” technologies created even more jobs.
It was a seemingly virtuous circle.

Looking
back over the sweep of time, it was. But it would have been impossible to
explain that to the farm workers who had to leave their farms in the 1800s
because of the McCormick reaper and go to the cities to find jobs, which were
not initially abundant. Eventually this labor was absorbed, but it took a lot
of time and retraining. And the process created political movements and a lot
of political angst. More on that process later.

Politicians,
who read public sentiment far better than economists do, recognized long ago
that people tend to fall back on free-market ideology and insist that open
international trade is always good. We haven’t always asked, though, whether
free trade helps everyone equally, or at the same time. We also have different
definitions of what constitutes “free trade.”

I
think confusion on these questions is driving populist trends around the globe.
History shows that such movements rarely end well. If we are to avoid a suboptimal
outcome, all sides will have to drop their preconceptions and find some common
ground.

Common
ground does exist. Perhaps I can offer a few ideas about how to search for it.

The Flatline
Economy

My May
15th “Life
on the Edge” letter drew more feedback and social media shares than
anything I’ve done in recent memory. I was commenting on the frustration that
drives many people to support Trump and Sanders.

In
that letter I talked about Peggy Noonan’s “Protected vs. Unprotected” paradigm.
One of her points was that the Protected class is basically considered the
elite of both parties.

My
friend George Friedman talked about one of his friends who came back from
England prior to the Brexit vote and said he had met no one who was for Brexit.
That is more a commentary on the social status of his friends than on the
actual vote. But exactly the same phenomenon occurs within the Protected
classes of both parties: they tend to talk exclusively to one another and so
are surprised when there is a wholesale uprising among the Unprotected (who
happen to be the overwhelming majority of voters).

Whichever
side you’re on (and I freely admit to being well-protected for the last half of
my life), it’s hard to deny reality. The last 20 years or so brought great
wealth to a few while most of the population was lucky to break even. Here’s an
update of Doug Short’s household income chart:

Inflation-adjusted
household income (blue line) in the US has gone nowhere in the last 16 years.
Notice also that it kept dropping even after we emerged from the last recession
(gray shaded area). Further, this is the median, not the average. Half the
households earn even less than this amount. Worse, the inflation adjustment is
based on the Consumer Price Index, which we know has understated the real cost
of living for most people.

Is
income flat because the economy hasn’t grown? In the next chart we have nominal
and real (inflation-adjusted) GDP for the same period. Notice that in simple
dollar terms the economy has roughly doubled in the past 18 years. Not bad
given two recessions, except that after you take out inflation, the economy has
grown only a little over 30%, roughly in line with 2%-a-year real GDP growth.

But
wait, you say, the previous chart showed median income slightly down since
2000. As Master Po on the TV series Kung
Fu would say, “Ah, Grasshopper, you must look deeper.” And if you
do, what you find is that GDP growth on a per capita basis – so that population
growth is accounted for – is less than 17% since 2000 and less than 2% since
the beginning of the Great Recession.

I

n
chained 2009 dollars, per capita GDP was $43,935 in Q1 2000 vs. $51,090 in Q1
2016. So the economy grew over 16% in total, but most households saw little or
no income growth. I should note that, omitting immigration, US population is
not growing all that much. You can make a case that what little growth there
has been in real per capita GDP over the last 10 years is mostly attributable
to immigration. Immigrants to the United States and their US-born children now
number approximately 81 million, or 26 percent of the overall population. On
average, over 1 million people per year immigrate to the US. (I could do a
whole letter on immigration. There are just a lot of issues that I can hear
readers calling to my attention now. I get them.)

Sidebar,
sort of on topic: Today we learned that GDP growth in the second quarter was a
mere 1.2%. The first quarter was downgraded, so the first six months of 2016
averaged only 1% annualized GDP growth. That’s barely stall speed. Inflation as
measured by the CPI is up only 1.1% from a year ago, nowhere near the 2% that
the Federal Reserve targets. Industrial production barely has a pulse.

Given
these numbers, care to make a prediction of exactly when the Federal Reserve is
going to feel comfortable raising rates even a mere 25 basis points? If you
choose any of the remaining meetings this year, I will take the “under” on that
wager. As I wrote a few weeks ago, the Fed had an opportunity to raise rates
beginning in 2014, but because they were afraid the market would throw a
tantrum, they simply didn’t have the, uh… (insert your favorite
politically incorrect term here) conviction fortitude courage confidence
nerve to do so.

Sidebar,
off-topic: We will never know what would have ensued if the Fed had raised
rates in 2014, but I bet they wish they could go back and have a do over. Their
world would look a lot different today with rates approaching 2%, and I doubt
the economy would be any worse off. Clearly, rising rates are not a problem
with this economy. The problems of this economy have been made worse by
monetary policy, and continuing to apply the same monetary policy principles
will not fix them; it will only make things worse.

Angry Charts

Here’s
another chart, from Sydney-based Minack Advisors. Their July 21 bulletin was
headlined “Angry Charts.” You’ll soon see why.

The
first chart we looked at was median income. That’s what the person right in the
middle made. That’s not average income, which is much higher. The average,
figured as the mathematically correct “mean family income” from the same St.
Louis Fed database, was $88,765 as of the beginning of 2014. The top 10%, and
especially the top 1/10 of 1%, raise the average for everybody. In a universe
of just Bill Gates and me, the average net worth is about $40,000,000,000. The
real world removes about five of those zeros for me. (In a fire sale, closer to
six. Please don’t tell my banker, who has a better opinion of me, at least
financially, than I do. Which is why I keep ignoring the concept of retirement.
I have a few zeros to go.)

Average
income for the top 10% of the population (red line, right-hand scale above)
rose roughly in line with that of the bottom 90% (blue line, left-hand scale)
from 1930 through 1970. Then something happened: income growth accelerated for
the top 10% and flattened for everyone else.

What
happened in the 1970s to cause this? We could point to many factors. One
obvious suspect is China’s opening to world trade and the onset of
globalization. Over the next few decades that process would transfer many
low-skilled jobs from the US to various emerging-market countries. It changed
the relative value of capital and labor all over the world. Wealthy people get
a larger share of their income from investments than from their labor. They own
the “means of production,” and the producers did increasingly well from the
’70s forward. That’s one reason the red line picked up steam.

Businesses
moved production overseas mainly to take advantage of lower labor costs. This
next chart, again from Minack, shows how manufacturing pay changed in the US,
Japan, Brazil, Korea, and China.

Some
of this wage convergence is due to currency movements, of course. Note also
that the chart has a semi-log scale. Each horizontal line is double the one
below it. Nevertheless, the results are pretty obvious. Chinese workers’ pay
grew more than 10x during this period. US factory workers saw much less wage
growth. Making workers from all these countries compete with each other had the
predictable effect: their pay converged into a narrower range.

The
result for American workers, once you consider taxes and inflation, is the flat
line in the chart above. The pain is greater for those with less education, as
we see in this chart from BLS. Anything less than a bachelor’s degree means
below-average wages.

People
in the lower tiers of this chart are struggling. Would getting them more
education help? Maybe, but getting them better jobs would help even more. It
isn’t happening, because those jobs no longer exist in this country. Hence
people’s attraction to Trump and Sanders, who promise to bring those jobs back.

But
what jobs? From where? Everybody talks about the demise of American
manufacturing, but that’s really a myth. Note in the chart below that in the
last 30 years US manufacturing output has almost doubled, while output per
worker is up 2.5 times and employment is down 30%. Since 1980, we have lost
nearly 9 million manufacturing jobs in the US.

The
losses are not due simply to outsourcing. There are other factors involved,
which we will get back to later in the letter. But first we need to look at
some of the prevailing wisdom that is gaining consensus on both the left and
the right.

Two Out of Three

David
Warsh, formerly of the Boston
Globe, wrote an interesting blog post last week, titled “Dani
Rodrik and Mr. Trump.” Warsh believes that Rodrik, a Harvard economist,
will be next to “enter the pantheon” of names we should all know. That’s
because Rodrik largely predicted the present situation in his 1997 book, Has Globalization Gone Too Far?

I have
not read this book, but Warsh makes it sound interesting. According to Warsh,
Rodrik argued two decades ago that trade would create deep divisions between
skilled and unskilled workers. Few of the gains from growing trade were going
to the less skilled, which Rodrik said would inevitably result in a backlash.
We can look back and see that the income gap between the Protected and the
Unprotected began to open in the mid-’70s. From the time Rodrik wrote his book,
it took 19 more years to get here, but the backlash has arrived.

Rodrik
later developed what he called the “globalization trilemma.” Democracy,
national sovereignty, and global integration were mutually exclusive, he said.
Nations could have any two of them but not all three, at least not in strong
form.

The
trilemma is an appealing explanation for some of today’s problems. The Brexit
fight pitted those who would sacrifice integration with the EU against those
willing to give up national sovereignty in economic matters.

US
political culture has looked much like the British “Leave” camp for most of our
history. We were big enough and possessed enough resources to grow nicely
without deeply integrating our economy with others.

If
you’re an American over age 50 or so, think about the word imported as people used it
in our youth. It connoted one of two things: either something super-expensive
you couldn’t afford, or something cheap you didn’t want. No one wanted a
Japanese car in the 1970s. They were unreliable and uncomfortable. Everyone
wanted GM and Ford for their American quality workmanship. I loved my 1966
yellow Mustang and lusted for a Corvette. Later I had a screaming muscle car (a
Mercury Cougar). A Datsun? A Honda? For whatever reason? Remember, I was buying
gasoline for $0.35/gallon in 1969.

Now,
of course, Japanese vehicles are every bit as good as what Detroit makes. I
actually bought one and like it better than the very similar American car that
I had before it. Japanese manufacturers have even moved some production here.
Meanwhile Detroit imports some parts from outside the US. So which cars are
really “American” now? It’s getting harder to say.

In one
sense, this is “free trade” delivering exactly what it is supposed to: better
quality at better prices. The theory was that these lower prices, along with
new and higher-paying job opportunities, would compensate for jobs lost to
cross-border competition.

Has it
worked out that way? For some people, yes. Think about your college friends
from 30 years ago. Most of them are doing all right, aren’t they? It’s easy to
forget they were your college
friends. The education they got plus the network they gained in the process
gave them a leg up. Whether or not a degree was actually required for a
position, these advantages moved them to the front of the line. But there are a
whole lot of people who didn’t go to college and don’t have those credentials
or contacts. Many of them are struggling.

There’s
no doubt globalization worked. NAFTA has been trashed by the current political
process as an example of a bad deal. But net-net, the data clearly demonstrates
that NAFTA has been a great benefit to the United States and to our two
partners. The problem is, the benefits of NAFTA were unevenly distributed.
There is no doubt it didn’t work for everyone. This isn’t an either/or issue.
I’m second to no one in defending free trade – but I also see the reality,
which is that globalization has had a dark side.

I will
argue in a few paragraphs that the dark side of globalization, at least in
terms of US (or other developed-country) employment income, is getting ready to
brighten. That might be good news, but other forces are at work that will
perpetuate the income divide.

Second
Thoughts on Free Trade

I’m
not the only ardent free trader who is having second thoughts. Stephen Roach,
formerly chief economist at Morgan Stanley, has a new Project Syndicate article
called “The
Globalization Disconnect.” I recommend you read the whole thing, as he goes
into some background that I will skip here. I want to go straight to the main
point. Here’s Roach:

Recent
trends in global trade are also flashing warning signs. According to the
International Monetary Fund, annual growth in the volume of world trade has
averaged just 3% over the 2009–2016 period – half the 6% rate from 1980 to
2008. This trend reflects not only the Great Recession, but also an unusually
anemic recovery. With world trade shifting to a decidedly lower trajectory,
political resistance to globalization has only intensified.

Of
course, this isn’t the first time that globalization has run into trouble.
Globalization 1.0 – the surge in global trade and international capital flows
that occurred in the late nineteenth and early twentieth centuries – met its
demise between World War I and the Great Depression. Global trade fell by some
60% from 1929 to 1932, as major economies turned inward and embraced
protectionist trade policies, such as America’s infamous Smoot-Hawley Tariff
Act of 1930.

But
the stakes may be greater if today’s more powerful globalization were to meet a
similar fate. In contrast to Globalization 1.0, which was largely confined to
the cross-border exchange of tangible (manufactured) goods, the scope of
Globalization 2.0 is far broader, including growing trade in many so-called
intangibles – once nontradable services.

Similarly,
the means
of Globalization 2.0 are far more sophisticated than those of its antecedent.
The connectivity of Globalization 1.0 occurred via ships and eventually railroads
and motor vehicles. Today, these transportation systems are far more advanced –
augmented by the Internet and its enhancement of global supply chains. The
Internet has also enabled instantaneous cross-border dissemination of
knowledge-based services such as software programming, engineering and design,
medical screening, and accounting, legal, and consulting work.

Globalization
2.0, as Roach calls it, is moving much faster than the original version did.
Some of this is due to technology, but trade agreements like NAFTA are
important, too. The barriers nations dropped to speed trade and economic growth
also turbocharged the rate at which workers found themselves displaced.

Is
this displacement an insurmountable problem? Maybe not, but we won’t solve it
until we recognize that it exists. Many economists and policy makers do not.
Here’s Roach again:

Sadly,
the economics profession has failed to grasp the inherent problems with
globalization. In fixating on an antiquated theory, they have all but ignored the
here and now of a mounting worker backlash. Yet the breadth and speed of
Globalization 2.0 demand new approaches to cushion the blows of this
disruption.

Ouch.
That hurts, but it’s important. Maybe the economists are right that
globalization will eventually bring us all to nirvana. Gene Roddenberry’s Star
Trek world, conceived in the 1970s, is one in which “replicators” can
manufacture anything virtually cost-free, which means that all human needs are
taken care of, leaving people to wonder what their purpose in life is. For
Roddenberry, that purpose was simply to go where no human had gone before. A
wonderful vision of the future, but even he situated it 300 years in the
future.

The
decidedly uncertain and clearly unknowable future is not much comfort to those
who experience disruption here and now. The future doesn’t pay this week’s
bills. In a democracy – which for now we still have – the Unprotected, the
Disrupted, those who’ve experienced the dark side of globalization, won’t
simply sit back and wait for better times. They’re hurting now, and they’re not
hurting quietly. They can’t afford to wait.

The
religious devotion to transcending borders and imposing common standards is
causing globalization to jump the shark. It’s a movement that flies in the face
of human nature. We are social creatures who naturally arrange ourselves into
families, neighborhoods, cities, states, and nations. We respect laws and
standards more readily when they are created and enforced at the lowest
possible level of that hierarchy.

Globalism
seeks to bypass all this natural law with top-down rules, often negotiated in
secret and then presented for rubber-stamp legislative approval in one
monster-sized, take-it-or-leave-it package. (In the US we make that process
sound nicer by calling it “fast track” – the authority granted the President by
the Congress to negotiate international agreements that Congress can approve or
deny but cannot amend or filibuster.)

Thus
economic integration as defined in modern trade agreements is incompatible with
national sovereignty as defined by populist politicians and voters. Make no
mistake about it: The Brexit vote was very close. The issue was not decided by
a broad consensus, and the second thoughts and regrets are beginning to
surface. On this side of the pond we tend to think of Brexit as an overwhelming
movement when, in fact, it just barely succeeded. Many of our own US
presidential elections have been quite close, if you look at the actual vote
count as opposed to the Electoral College count. In European countries, parties
quite often fail to win enough votes to achieve a majority, and coalitions
among competing parties, often with differing ideologies, have to be cobbled
together in order to run a country. That’s democracy for you.

We
must find comfort in the words of Winston Churchill: “Democracy is the worst
form of government, except for all those other forms that have been tried….”

The
global economy is no longer about making a product in one country, and shipping
and selling it somewhere else. It is about complex supply chains that weave together activities all over the
globe, supported by investment, technology, and skills that know no borders.

Creating
an even playing field is no longer just about reducing external tariffs and
quotas, but about coordinating and sometimes
revising what have traditionally been seen as domestic policies to
“stabilize” agriculture, promote national culture and identity, encourage
innovation, protect health and safety, and ensure citizens a certain minimum
quality of life.

Critics
of the Trans-Pacific Partnership (TPP) argue it is no mere “trade” deal, and
they are right: more accurately, it is a
package of integrated economic policies that will increasingly fuse several national economies into a
single marketplace.

Where
to begin? Countries don’t share the same experiences or perspectives. That is
what makes them different countries. George Friedman always distinguishes
between nations and states. A nation is a people with a common language,
history, and culture. A state is simply a government. Forcing people of
different nations to share one state, or separating them into multiple states,
is what causes conflict and sometimes war.

“Free
trade” deals are no longer simple documents. The Trans-Pacific Partnership
(TPP) weighs in at 5,544 pages. It’s a boatload of rules and regulations. I
know there is talk that this deal was negotiated in secret, but that is far
from the truth. You and I weren’t asked for input, but lots of people were, let
me assure you. I can guarantee you that rice farmers in Texas and California
were pressing their congressmen and others for access to the lucrative Japanese
market, and Japanese rice farmers were trying to figure out how to limit the
damage. For the record, Japan imports about 10% of its rice from the US, most
of which they turn around and export as foreign aid or use for animal food. It
is not that Japanese rice is that much better; indeed, the fact that US rice is
so close in quality makes Japanese farmers nervous. And US rice is 1/3 to 1/2
the cost of Japanese rice.

Of course
Japanese companies want access to US markets, where they can compete quite
well, thank you, against US firms. And those US firms want to keep the
protections and prices they have. This tit for tat has gone back and forth in
hundreds of industries in the 12 countries involved in the TPP. I can guarantee
you that wheat farmers or corn farmers or cattle or hog producers have a
different view of the whole process than US rice farmers do. And their views
are different again from those of equipment manufacturers or software
developers, or pick any of 1,000 industries. Rice farmers in Japan have to
negotiate terms of trade with other national industries, and do you think New
Zealand avocado farms or sheep farmers or movie firms have any less interest in
the process?

Every
country is worried about US companies coming in and overwhelming their
businesses, and the US is worried about “unfair” competition – that is,
competitors in other countries producing products that are cheaper or better.
Often, the higher cost of products here is attributable to the regulations that
we impose on our own industries. So we want other countries to abide by our
regulations (and they want us to abide by theirs).

The
problem with global deals like TPP and its US-European counterpart, TTIP, is
that while they may be good for the economies as a whole, citizens will find
that “good” very unevenly distributed, which is why Trump calls such agreements
“a job and independence threat.” After supporting the TPP for several years,
Clinton now says she will not sign. Both candidates are responding to the very
real problems generated by the uneven distribution of globalization’s benefits
over the last 30 years.

We are
actually in the process of re-shoring manufacturing back to the United States. But
just because factories are coming back doesn’t mean jobs are – a factory that
relies on robots has an advantage if it is near its markets. When Foxconn in
China is installing robots in a factory and reducing the number of workers
there from 110,000 to 50,000, you know the labor arbitrage game is coming to an
end. And that is just one factory.

I have
persuaded my friend Marin Katusa, one of the smartest and most successful
natural resource investors I know, to reproduce in a special report for Outside the Box the
highlights of a long conversation we had in Las Vegas a few weeks ago. He
absolutely astounded in describing the changes that are coming to the mining
and oil-drilling world – and I thought I was relatively up to date. The number
of workers that will be employed in those industries in 10 years will be an
order of magnitude smaller, yet production will dramatically increase.

Self-driving
trucks and cars will clearly have an impact on truck and taxi drivers. But
think of the impact on insurance companies. Estimates are that revenues will
drop by as much as 75% over the coming decades. And we won’t need as many small
local businesses to repair vehicles after accidents. A score of related
industries will all see disintermediation. And that’s just one industry.

The
changes that occurred as the workplace shifted from the family farm to urban
manufacturing took place over decades and generations. While the shift was
uncomfortable for many people, there was time to adapt to the changes.

It is
almost a cliché to say that today things are changing ever faster. But most of
the changes that are producing social angst have happened in the last 30 years
– that is, within the productive lifetime of most people. Adapting to such
rapid and unrelenting change has been harder. A surprising reversal of trend in
mortality statistics is that white middle-aged males are now dying at an
increasing rate due to drug and alcohol abuse and depression.

Clearly,
disintermediation – the elimination of middlemen and the displacement of labor
– is doing more than just making voters angry. It is stealing away the hopes of
significant subsets of entire generations. When your well-paying job goes away
and you can’t find a replacement, the loss hits your sense of self-worth along
with your bank account.

As
whole new industries develop, the advancing wave of technology will continue to
create jobs, but generally not jobs that will require old skills. Humans have
always had to adapt, but the speed at which we must adapt is accelerating. In the
past, it has been the young who have done most of the adapting as they have
learned new skills for new jobs. In the future the young will still be part of
the adaptation process; but, more and more, those in their 40s and 50s and 60s
will be called upon to change as well.

The
Protected class is right to feel uncomfortable. The anger of the Unprotected is
not just an election-year, flash-in-the-pan phenomenon; it is a movement sure
to grow in direct proportion to the extent that the wall of protection crumbles
for more and more people.

The
presidential candidates offer radically different methodologies to restore
protection. But they are fighting the last war, with the tools of the last war.
The impulse of both major political parties is to protect their constituents
from unwanted change. Unfortunately, protection from change for a few comes at
the price of limited choices and reduced freedom for everyone. In an
increasingly globalized world, the regulators are increasingly becoming prison
guards. The FCC wants to regulate the Internet as a utility. It’s just one of
thousands of regulatory bodies that wants to increase its power because some
constituency is lobbying for protection from its competitors or for the
promotion of its pet project or cause.

In a
future that’s not very far off, the only way to truly protect yourself will be
to learn to continually adapt.

And
it’s not just workers that must learn to surf inevitable change; it’s
businesses, too. Elon Musk may be a visionary, and his gigafactory to make
batteries may revolutionize that whole industry, but I will make you a side
bet: Whatever the first set of batteries that comes out of that factory looks
like, the entire process of battery design and production will continue to
change dramatically, and by 2030 Elon’s factory will be obsolete. The only way
he will survive is by adapting and staying on the bleeding edge of innovation,
obsoleting his own factory if necessary. Think Kodak and Blockbuster and 100
other firms that failed to adapt. But those firms were composed of people who
made plans for the future, plans that had to change.

There
is much more to say about all this, and I will continue to write about it in
the coming year.

Maine, New York,
Montana, and Iceland

Wednesday
I dive into a rather hectic two weeks (for somebody who was intending to stay
home for the summer). I go on our regular Maine economics-fishing trip for the
10th time, come back to New York for a few days, then head out to
Montana, where I actually get to research a chapter of my new book with five
young rocket scientists whom good friend Darrell Cain has gathered to expand my
mind. Then I come back to Dallas for a day before heading out to Iceland to
learn about the future of energy and natural resources. I’ve never been to Iceland,
and I’m looking forward to talking to people there about what it was like to go
through their crisis, comparing their remarks with the conversations I’ve had
with people in Greece and Cyprus. I will report back.

About
two summers ago I met Marc Chaikin, the founder of Chaikin Analytics, who spent
a few hours in a quiet hole-in-the-wall pub, showing me the latest version of
his stock and fund analytical software. We can politely call Marc a veteran of
the markets who has used a variety of methodologies to buy, sell, and trade
stocks (he started trading in 1965 and has had a rather storied Wall Street
career). He actually developed some of the techniques and indicators that most
technical traders use today. He has forgotten more than I’ll ever know about analyzing
stocks.

In the
latest generation of his software, he has married the merits of fundamental
analysis with the numerous techniques of technical trading to generate entry
and exit signals for equities. I’m impressed by what he has done, though trading
stocks is not something I do. I have spent my career learning to analyze money
managers, a completely different skill set. Marc has wanted to partner with my
firm, but I truly had no way to evaluate his work in comparison to all the
other systems that are out there.

So he
agreed to give my analyst team his software and training and turn them loose.
Given that they have access to just about any other system they want to use,
they are in a far better position than I am to understand the relative merits
of trading technologies. Two years later, they are enthusiastic users of
Chaikin Analytics and use it to analyze the trades and recommendations of our
writing team, giving them feedback and insight into their own ideas. Marc’s
system has been integrated into our routine due-diligence process for vetting
and evaluating potential investments.

Mauldin
Economics Publisher Ed D’Agostino and our team are going to be doing a webinar
with Marc week after next; and if you are involved in the stock market, I would
encourage you to tune in to his presentation. You can register for the webinar here.

This
will be the 10th year that my son Trey and I have journeyed to Leen’s
Lodge in Grand Lake Stream, Maine, to participate in Camp Kotok. Around 50
economist types, analysts, and media gather to spend three or four days
fishing, eating fabulous food (owner Charles Driza serves up gourmet dinners),
and perhaps indulging in an adult beverage or two. Everybody brings more wine
and other such beverages that any of us can possibly drink.

A
typical day involves getting up, eating a big breakfast with more calories than
I usually consume in a day, getting out on the lake, and trying to find
someplace where the fish are biting. Then around noon we all gather, and the
guides clean fish and cook for us. Then we go back out and fish some more, then
clean up a bit and assemble in the late afternoon for more conversation and
food. Some of the local guides provide music, and poker games generally start
up as the evening develops. You know the old line about how you look around the
table and wonder who the patsy is? I figured out the answer to that question
after a few years and generally try to refrain from donating my money to people
who already have a lot more than I do. I wouldn’t mind so much, but they keep
reminding me how much they beat me up in years past.

Trey
was only 12 when we first went to Maine, and he has grown up with many of these
fishing friends. I go back and look at some of the pictures from summers past,
and it’s hard to believe not only how much Trey has grown but how fast he’s
grown. The first time we went to Camp Kotok seems like only yesterday. We still
have a friendly competition to see who catches the most fish. He generally
skunks me. We fished from canoes for the first few years, as that is the
classic Maine guide experience; but I much prefer the larger boat that our
current guide provides, and we generally invite a guest to broaden the
conversation. One of the limits on the number of people who can come to the
event is that we actually utilize about every guide in the area. They tell us
Camp Kotok is the event with the biggest economic impact on the county, which
is actually the poorest county in the US. As logging and paper mills close,
jobs become scarce. Some of the guides are from the local Passamaquoddy tribe,
and we actually fish on their lakes and lands at times.

When
David Kotok, who organizes the event, first approached me about coming, I was
somewhat skeptical, as I don’t really fish much and Grand Lake Stream is one of
the few places in the US that you just can’t get to in one day. Trey and I have
to fly into New York, then fly to Bangor the following day, and then drive a
few hours. People ask me how far north it is, and the best answer I can give is
that when you are out on the lake, you’re picking up cell signal from Bell
Canada. Which is actually good, because when you get back to the lodge there is
no signal. There is internet, but with everybody trying to get on, it gets slo-o-o-ow.

This
year’s drive to the camp will be special, because my good friend Neil Howe,
philosopher and generational expert, as well as my associate Patrick Watson,
will be in the car with us.

The
weekend is conducted under Chatham House rules, which means that everybody
opens up and throws out their most outrageous ideas, looking for pushback and
comment. It becomes a pretty freewheeling discussion. If you want to quote
anybody, you have to ask permission.

And
now it really is time to hit the send button. I will spend the next few days
with my iPad, taking practice exams for yet another regulatory license that I
have to have for my new venture. My intention now is to take the test Monday
afternoon and have it out of the way before I take off on my travels. Which
means I now get to sit in front of a computer for about 12 hours, getting up to
speed. But I do get to look forward to Maine, so I doubt that anyone will feel
sorry for me. Have a great week.

The Communist Party is trying to ensure it can hold the country together.

By Jacob L. Shapiro

It is almost difficult to remember that the top story at the start of 2016 had nothing to do with Brexit, instability in Turkey or Europe’s banking troubles. This year began with a series of crashes in the Chinese stock market that sent global markets into a small panic. That caused many to question the capabilities of decision-makers at the top of the Chinese economy and led to large capital outflows, which totaled just below $100 billion in January alone.After a few weeks, Beijing was able to get the situation under control by falling back on an old strategy: pumping money into the domestic economy. But this time it did so at an unprecedented rate. The total amount of social financing used during the first quarter of 2016 surpassed the stimulus China relied on to get through any quarter since the 2008 financial crisis. The stimulus did the job and stanched the bleeding. But it looks like the bandage is beginning to fall off and China is still staring down the barrel of the same structural economic challenges it had in January.One of the most worrying signals comes straight from the People’s Bank of China (PBOC). The head analyst for the PBOC reportedly said that China was falling into a “liquidity trap.” China has been able to maintain its targeted GDP growth rates so far this year, but beneath the veneer of positive news in the first half of the year is the distressing observation that many private enterprises are hoarding capital rather than investing it back into the economy.One worrying sign is that though private investment has been declining in China since 2012, it has fallen off a cliff in 2016, reaching record lows of 2.8 percent year-over-year growth. Total investment is growing at more than 10 percent, but that is driven largely by state investment. As a portion of overall investment in China, private investment in May was at its lowest in four years.

At the same time, capital outflows are beginning to pick up again. Goldman Sachs estimated at the end of last week that foreign exchange outflows from China doubled in June from the previous month, approaching almost $50 billion. Non-performing loans are creeping upward, reaching 1.75 percent of total bank lending at the end of the second quarter, according to the China Banking Regulatory Commission. Even more worrying, unofficial statistics suggest the true percent of total loans that are non-performing in China could be anywhere from 3 percent to 20 percent.Amid these warning signs, fresh rumors abound about discord between President Xi Jinping and Premier Li Keqiang. An article in the Wall Street Journal on July 22 stated that the discord between Xi and Li was spilling into the open and highlighted contradictory statements the two made at a meeting of China’s State Council on July 4. According to the Wall Street Journal, Xi seemed to be calling for “stronger, better, bigger” state-owned enterprises (SOEs), while Li emphasizes that SOEs should “slim down” and “follow market rules.”We first began tracking rumors of discord on May 9 after a piece was published in the People’s Daily newspaper – citing an unnamed “authoritative insider” – that has been interpreted by many as a not-so-subtle critique of Li’s economic policies.The critique levied by the “authoritative insider” plays a relatively minor role in the development of this potential split, and its importance has been exaggerated. It is far more consequential that since Xi came to office, he has systematically taken control of economic policy-making in China, which historically came under the purview of the premier. He has sidelined Li by confining Li’s responsibilities to various smaller committees that either Xi runs or are directly answerable to him.Xi has been consolidating power since he came to office in 2012, and now cracks in his authority seem to be few and far between. The anti-corruption campaign is continuing apace, dismantling and reorganizing any group that could meaningfully challenge Xi’s rule. The People’s Liberation Army is also being reorganized and as far as we can tell has not resisted Xi’s consolidation attempts in any meaningful way. Xi seems to be very much in control in China and the most serious challenge that anyone has proffered at this stage amounts to just whispers and rumors ahead of next year’s 19th Party Congress.It is hard to make very much of these whispers at this point. For one thing, anyone who claims that they know precisely what is going on between Xi and Li either has a direct connection to both men or is simply guessing. For another, personalities matter relatively little at this level of geopolitics. Xi and Li are political leaders in China and both are looking at the same set of problems and trying to figure out the best way for Beijing to address them. Unless something dramatically changes, Li doesn’t have the power necessary to unseat Xi or to challenge him for the presidency, and a “leadership struggle” between the two will most likely end with Li losing the premiership five years earlier than is customary.What we can say is that, without having a complete transcript of the State Council meeting on July 4, it is impossible to know whether Xi and Li really were contradicting each other. But wanting bigger and stronger SOEs and wanting bloated inefficient ones to trim down are not necessarily mutually exclusive paths. If Li is smarting from loss of authority in his role or from lingering embarrassment from the critiques of the previously mentioned “authoritative insider,” he isn’t letting it show. On July 21, while speaking directly to provincial governors, he backed Xi’s supply-side reforms by exhorting the governors to eliminate inefficiencies and encourage private investment.The more important point is that Li even has to do that in the first place. The problems that are showing up at political and economic levels throughout China stem from a divide between what is good for individual regions and what the central government believes is good for China. Just two months ago, Xi spoke at a meeting of the Central Leading Group for Financial and Economic Affairs, which Li also attended, and pointed out that some regions had “not yet taken effective actions” in responding to the directives of the central government. Whether or not there is a crisis of leadership emerging, the most important point in the Wall Street Journal article was that some Chinese officials claim to be confused about which policies they should follow and therefore are sitting on the sidelines instead of pursuing Beijing’s priorities for the country. Much is made of the fact that the Chinese Communist Party derives its legitimacy from presenting a unified front, making sure unemployment stays low, or containing social unrest. This is of course true, but it is in many ways an oversimplification. There is a push and pull between the center and the periphery in China, and Beijing cannot simply tell the provinces what to do and expect it to be done with no questions asked. When we say that the Communist Party’s legitimacy is at stake, we are really talking about the party’s ability to govern. Xi may very well be a dictator, but the ability to make China function as one country is rooted in Beijing’s ability to convince the various local areas that they should pursue reforms because these reforms are in their interest, and not just because Xi tells them to do so. The party’s legitimacy is one of the most important currencies Xi has to accomplish this, and a fight between Xi and Li would severely weaken that currency.And that is the real crux of the problem. Whether there is serious discord at the top is less important than the fact that even the appearance of disagreement can have serious ramifications for China’s ability to pull off the massive economic restructuring it is attempting. As for Xi and Li, if they are on the path to a struggle for the party’s leadership, it wouldn’t be the first time that two similarly minded political leaders chose to fight each other rather than face their shared problems. But even if they are, China's problems are bigger than either of them.

It is a sad commentary on the state of political life in the United States that our political conventions have become more like rock music festivals than competitions of ideas. There has been a great deal of bombast, of insults, of name-calling, and of chest-beating at both party conventions, but what is disturbingly absent is any mention of how we got to this crisis and how we can get out. From the current foreign policy mess to the looming economic collapse, all we hear is both party candidates saying they will fix it, no problem.In her convention speech Hillary Clinton promised that she would "fight terrorism" and defeat ISIS by doing more of what we have been doing all along: bombing. In fact we have dropped more than 50,000 bombs on ISIS in Iraq and Syria over the past two years and all she can say is that she will drop more. How many more bombs will defeat ISIS? How many more years will she keep us in our longest war, Afghanistan? She doesn't say.In fact, the New York Times - certainly not hostile to the Clintons - wrote that it was almost impossible to fact-check Hillary's speech because, "she delivered a speech that was remarkably without hard facts."Clinton's top foreign policy advisor said just a day after her convention speech that her big plan for Syria was to go back to square one and concentrate on overthrowing its secular president. How many more thousands more will die if she gets her way? And won't she eventually be forced to launch a massive US ground invasion that will also kill more Americans?Clinton does not understand that a policy of endless interventionism has brought us to our knees and made us far weaker. Does she really expect us to be the policemen of the world with $20 trillion in debt?Likewise, Republican candidate Donald Trump misses the point. He promises to bring back jobs to America without any understanding of the policies that led to their departure in the first place. Yes, he is correct that the middle class is in worse shape than when Obama took office, but not once did he mention how it happened: the destructive policies of the Federal Reserve. The financing of our warfare/welfare state through the printing of phony money. Distorted interest rates that encourage consumption and discourage saving and investment.Trump tweeted this week that home ownership is at its lowest rate in 51 years. He promised that if elected he will bring back "the American dream." He seems to have no idea that home ownership is so low because the Fed-created housing bubble exploded in 2007-2008, forcing millions of Americans who did not have the means to actually purchase a home to lose their homes. Not a word about the Fed from Trump.How are these candidates going to fix the problems we face in America if they have absolutely no idea what caused the problems? No matter who is elected, Americans are going to be very disappointed in the outcome. The warfare/welfare state is going to proceed until we are bankrupt. There is hope, however. It is up to us to focus on the issues, to focus on educating ourselves and others, and to demand that politicians listen.

- The dollar relationship is a mirage.- Gold lower than recent highs but strong.- Silver lower than recent highs but very strong.- Platinum and palladium show signs of life.- Higher highs and higher lows on the horizon.

Last week we heard from the U.S. Federal Reserve Open Market Committee, and there was no surprise in their action or lack thereof. The FOMC voted to leave interest rates unchanged while issuing a statement pointing to moderate growth in the U.S. economy, an improving labor market, and citing gains in payrolls in the June report. All of the data inputs needed for an increase in the Fed Funds rate appeared to be present as the committee met in July but the central bank decided to leave rates unchanged.In December 2015, the Fed hiked interest rates for the first time in nine years and promised 3-4 more hikes in 2016. With seven months behind us, they have not kept their promise. The Fed has vacillated between excuses and promises over the first seven meetings of 2016, and the July meeting left markets with yet another promise. Some analysts now expect a rate rise at the September or December meeting, but in my view, they are dreaming. The U.S. Presidential election will supply the next series of excuses for the central banks to leave rates unchanged and at the current artificially low level.Precious metals have been the only accurate reflection of central bank policies in the United States and around the world.

The dollar relationship is a mirage

Last week, as markets prepared for the latest interest rate decision from the Fed, precious metal prices moved lower from highs seen after the surprising results of the Brexit vote. When news of another month of no change in monetary policy hit the markets, precious metals rallied sharply. The move in the dollar index was mild. Then Friday the dollar moved lower perhaps more due to disappointing action from the Bank of Japan..As the daily chart of the dollar index highlights, the index peaked at 97.62 on the September futures contract on July 25 and fell to 96.721 by the close of business last Thursday, the day following the latest Fed announcement. The greenback fell to lows of 95.335 last Friday and the greenback put in a bearish key-reversal trading pattern on the weekly chart on low volume. The dollar made a marginal new high on the week and then closed below the prior week's lows.Despite the bearish reversal, the dollar continues to trade close to the highs of the trading range since May 2014, the action in precious metals gives reason to pause. Since late 2015 and early 2016, the prices of all of the major precious metals traded on futures exchanges have rallied in dollar terms. In fact, gold, silver, platinum and palladium have moved higher in all currency terms over recent months. Precious metals are making an important statement on the value proposition for all currencies. These shiny metals are telling us that the value of all paper foreign exchange instruments has moved lower. The "strong dollar" is only strong when compared to other paper currencies, compared to precious metals the dollar has weakened. Therefore, the argument for a high dollar has been more myth than reality.

Gold lower than recent highs but strongGold moved to highs of $1377.50 in July following the Brexit surprise and since then has corrected lower reaching a recent bottom of $1310.70 before the latest Fed missive..Meanwhile, the monthly chart of COMEX gold futures illustrates that the momentum of the yellow metal is still bullish and with substantial volume and open interest. The increase in volume and number of long and short positions in COMEX gold futures provides technical support for more price appreciation. While it is possible that gold could correct lower, key support is now far below current prices. The 50% retracement level of the move from $1046.20 in December of 2015 to the recent highs is at $1211.85 per ounce. Therefore, a move back to $1280 or $1250 would not reverse the bullish market trend for gold. Resistance is now at the March 2015 highs of $1392.60 per ounce and the August 2013 highs of $1428, which is my initial upside target for the yellow metal. Gold closed last Friday at the $1358 level, over $300 or almost 30% above the December 2015 lows. As a side note, gold put in a bullish key-reversal trading pattern on the daily chart last Friday on moderate volume.While gold remains firmly in a bullish trend, the performance of silver has been even more exciting over recent weeks.

Silver lower than recent highsbutvery strong

Silver reached lows of $13.635 per ounce last December. In July, the price of gold's little brother peaked at $21.095, an increase of almost 55%..

The extraordinary move in silver came as a delayed reaction to the move in gold. Silver had taken its time before it exploded higher starting in April. The monthly chart of COMEX silver futures highlights significant bullish momentum. Large volume and rising open interest validate the move from a technical perspective. In fact, open interest has increased to all-time highs, an indication that the action in silver is attracting new market participants.The value proposition for silver may be more bullish than the price trend itself. The price volatility in the silver-gold ratio demonstrates the strength of silver compared to gold over recent weeks.

The monthly pictorial of the silver-gold ratio shows that it traded to the highest level since 1995 in March of 2016 when it reached over 83:1. Since then, the ratio has dropped to 66.3:1 or 66.3 ounces of silver value in each ounce of gold value. The long-term average for this price relationship is 55:1 however it tends to deviate from that mean level over time. Over the course of history, during bear market periods in the precious metals sector the ratio tends to move higher and during bull market periods it tends to move lower. The move since in this inter-commodity spread over recent months is further confirmation of the bull market in precious metals.

Support for silver is at the 50% retracement level of the move from the December lows to recent highs and stands at the $17.365. Silver closed last Friday at the $20.38 level on the September futures contract. At this point, the precious metal could withstand a severe selloff and still be in a long-term bullish trend. However, my initial upside target for silver is the August 2013 highs at $25.12 per ounce. A gold price of $1,358 would imply silver at $24.70 if the silver-gold ratio were to return to its historical norm.

The other two precious metals that trade on futures exchanges also have displayed signs of life over recent weeks.Platinum and palladium show signs of life

Platinum and palladium are both industrial and precious metals. They each have a myriad of applications in industry, but each is rare and has a history of investment and speculative interest. Given the weakness in the global economy, platinum and palladium had remained at depressed levels but recently, they have rebounded dramatically along with gold and silver, their precious cousins. .

The monthly chart of NYMEX palladium futures shows the rally from $451.50 at the beginning of 2016 to highs of $715.90 last week, an increase of over 58.5%. Momentum on the price of palladium is currently higher while open interest is rising and relative strength is climbing over recent weeks. While palladium has outperformed on a percentage basis, the action in platinum, a more actively traded precious metal, is even more compelling for the sector..

NYMEX platinum futures have appreciated from lows of $812.10 in January 2016 to highs of $1,163.80 last week. The increase of over 43% has created positive momentum for the precious metal, and open interest has grown to an all-time high. The value proposition for platinum versus gold has also improved over recent weeks. The long-term (40-year) average for the price differential between platinum and gold has been around a $200 premium for platinum over the yellow metal. That is why platinum often has the nickname "rich man's gold." However, since late 2014, platinum has traded at a discount to the price of gold. That discount reached an all-time low of around $350 per ounce at the end of June of 2016. Since then platinum has outperformed gold.

As the daily chart of the price of platinum minus the price of gold illustrates, the spread has moved from over a $350 discount to around a $200 discount over the past month. Platinum remains around $400 below its long-term average level versus gold. During bear markets in precious metals the discount of platinum under gold tends to increase and during bull markets platinum tends to outperform gold. In 2008, when both platinum and gold broke to new all-time highs, platinum traded at over a $1,200 per ounce premium to the price of gold.Platinum closed last Friday at $1,154 per ounce, with gold at $1,358 a return to the long-term norm in the spread would put platinum at $1,558 per ounce. Technical resistance for platinum on the monthly chart is at $1,289 and $1,514. The 50% retracement level for platinum and palladium are at $986 and $580, respectively. Both metals are significantly above their critical support levels, but both have room for corrections.

Higher highs and higher lows on the horizon

Markets never move in a straight line. There is often a tremendous amount of volatility in even the strongest bull markets. I believe that all evidence points to an important bull market in the four major precious metals that may only be in its very early stages.The price moves and momentum in all four metals compliment increasing open interest and volume in the futures as well as the ETF and ETN markets providing technical validation for the price appreciation. Additionally, fundamentals may have never been better for the precious metals sector. Fear and uncertainty in the global economic and political landscapes continue to provide the rationale for higher prices. Investment demand for precious metals continues to increase.In May of this year, the Swiss exported a record amount of gold to the United States. The Swiss shipments totaled 20.7 metric tons, more than 50 times the average monthly exports and an amount that is more than the total gross exports for all months dating back to 2000. With record levels of open interest in the silver and platinum futures markets and the inter-commodity price relationships between gold and its precious cousins moving in a direction that implies a bull market, precious metals are flashing ominous signs. The conventional wisdom is that precious metals increase in value during inflationary periods in history. The rallies in these four metals may just be a significant harbinger of a future inflationary spiral, the result of years of central bank accommodation.I believe that precious metals will rise to levels that many analysts have not ever considered, over the years to come. However, the road will be bumpy, and the opportunity to buy on dips will allow investors and traders to hop on board the precious metals freight train that is a long way from its final destination.

We are travelers on a cosmic journey, stardust, swirling and dancing in the eddies and whirlpools of infinity. Life is eternal. We have stopped for a moment to encounter each other, to meet, to love, to share.This is a precious moment. It is a little parenthesis in eternity.